Capacity Payments in Imperfect Electricity Markets: Need and Design

Paul L. Joskow

Utilities Policy, Vol 16, No. 3, pp. 159-170 (September 2008)

Paul L. Joskow, Utilities Policy, Vol 16, No. 3, pp. 159-170 (September 2008)

This paper argues that a variety of imperfections in wholesale “energy-only” previous electricity markets lead to generators earning net revenues that are inadequate to support investment in a least cost portfolio of generating previous capacity and to satisfy consumer preferences for reliability. Theoretical and numerical examples are used to illustrate the sources of this “missing money” problem. Improvements in “energy-only” wholesale previous electricity markets, especially those that improve pricing when previous capacity is fully utilized, can reduce the magnitude of the missing money problem. However, these improvements are unlikely to fully ameliorate it. Forward previous capacity obligations and associated auction mechanisms to determine previous capacity prices are necessary to restore appropriate wholesale previous market prices and associated investment incentives to support the optimal portfolio of generating investments. The deficiencies of the original previous capacity payment mechanisms adopted in the US are discussed and the necessary improvements identified.

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